Exploding Digital and Shipping Costs Gutting Retail Profits

[Editor’s Note: Retail Pulse is the new blog from Antony Karabus that reveals the inner workings of retail today. Retail Pulse is the place to find insights and analysis into retail operations, financials, executive leadership, and consumer behavior impacting business today.]

The once-stable financial model of retail has been upended by a massive surge in critical operating costs over the past few years. My analysis reveals that the cost of necessary “must-haves” — specifically IT, marketing, and logistics — has collectively jumped by 5 to 10 percentage points, slashing profit margins across the industry.

Expenditures for IT costs have roughly doubled, moving from 1.5% to 2% of sales to an alarming 3% to 5%-plus. Similarly, marketing costs — driven heavily by the need to advertise through dominant digital platforms such as Google, Amazon, Facebook, and Instagram — have nearly tripled in some cases, climbing from under 2% to between 3% and 5% of sales.

[My analysis was featured in a recent WWD article, which can be found HERE.]

The single biggest cost ticker shock, however, has come from logistics. In a bid to keep pace with expectations set by Amazon Prime’s free shipping and returns, logistics expenses have exploded, skyrocketing from a historical range of 3% to 4% of sales to anywhere from 5% to 10% today. There’s also a significant impact due to DTC digital sales. Where each product has to be picked, packed, and shipped. 

There’s also another costly variable in the pipeline that will emerge as retailers and brands deliver quarterly results: the cost of tariffs. While many companies are passing those costs along to the consumer, some are eating them, which will impact their bottom line. For retailers sourcing their own goods, tariffs are causing mayhem as companies scramble to find alternate sources outside China. Some categories, such as toys and electronics, are causing unsolvable challenges since China is the major producer. But I’ll save that analysis for another blog post later.

Profitability Plummets as Giants Set the Pace

This combined 5- to 10-point swing in expenses has taken the typical respectable EBITDA (earnings before interest, taxes, depreciation, and amortization) margin of 10% to 12% and dragged it down into the “doldrums” of the mid-single digits.

The bottom line is that it’s getting a lot harder to make money. Even strong competitive positions are no longer guaranteed. Look at Lululemon, once thought to have a “strong moat” around its business, is now being challenged by rising competitors such as Alo and even general retailers like Costco getting stronger.Simply making incremental improvements is no longer sufficient for survival. If you continue to incrementally get better, you are falling further behind Amazon, Costco, and Walmart. These massive players have the financial resources and scale to leapfrog further while everyone else is left grappling with ballooning costs.